Comments on Smith Barney's Uranium Enrichment Analysis

Published by the Government Accountability Office on 1990-07-31.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                         United States General Accounting Office   /q   / q/   r       . I,

6 GAO                    Testimony

     For Release         Com m ents on S m ith Barney's     Uranium
     on Delivery         Enrichm ent  Analysis
     Expected at
     lo:00 a.m . EDT
     July 31, 1990

                         Statem ent   of
                         Victor    S. Rezendes, Director,    Energy      Issues
                         Resources,    Com m unity, and Econom ic
                            Developm ent  Division
                         Before the
                         Subcom m ittee on Energy and the Environm ent
                         Com m ittee on Interior  and Insular Affairs
                         House of Representatives
                         and the
                         Subcom m ittee on Energy and Power
                         Com m ittee on Energy and Com m erce
                         House of Representatives

                                                                         GAO Fom   160 (12/87)
Mr.        Chairmen       and Members of the                        Subcommittees:

            We appreciate               the      opportunity           to present           our views           on the May
1990 Smith              Barney,         Harris        Upham and Co. Incorporated                          financial
assessment              of the         Department           of Energy's:          (DOE) uranium                enrichment
program,           specifically               the     issue         of unrecovered             government            costs.
We will          also     discuss          Smith       Barney's         conclusions             related         to
environmental               and decommissioning                       costs     and the         eventual         sale       of
the    program           to the         private        sector.

            In summary,           Smith          Barney       concluded         the      following:

            --   The enrichment                  program       should         be restructured                 as a
                 government             corporation            and should             operate     in a competitive,
                 businesslike             manner.             Over the         last     several        years,         we too
                 have supported                  restructuring            the program            as a government
                 corporation             subject           to the      Government          Corporation               Control

           --    All     past     costs          have been recovered,                   and DOE's customers
                 have overpaid                about        $1.2 billion,              rather     than         underpaid
                 about      $9.6       billion         as we have reported.                      In reality,               total
                 costs      have not             been recovered               through      revenues;            rather,
                 Smith      Barney        assumed that                DOE could         reduce        total      costs        by
                 making      various             adjustments           and policy          decisions.                Our
                 position         is     that       only      the     Congress         can authorize             these

          reductions.             Although            we do not               believe           that         full       cost
          recovery        is    possible,             DOE estimates                    that      the         corporationls
          future       earnings          could        be substantial:                         As a result,                   we have
          suggested        that         the    Congress              require           the      repayment               of      $3
         billion        that      DOE is         pric ing          to recover,                 rather            than        rely
          solely       on unspecified                 div idends              and/or          uncertain               future
         s toc k     sales .

         The government                 should        retain          responsibility                       for
         environmental             and decommis s ioning                         costs         associated                 with
         enriched        uranium          production               before         the         corporation's
         formation.             Smith         Barney         did      not      identify              the      costs          that
         should       be borne           by the         corporation               nor did              the       company
         specify        a method          to allocate                 total       costs          between             the
         government            and the         corporation.                    Because           these           costs        are
         largely        undefined,             we support              legis lative                  proposals               that
         would       require       the        corporation              to establish                    a fund          to
         decommis s ion           the     three         exis ting             plants          with      the         government
         matching        the      corporation's                contributions .

    -- At some future               time         (not        specified)            the         corporation                   could
         be sold       to the       private            sector.              Unles s           problems              related          to
         licensing         uncertainties ,                   increased            competition,                      and
         billions        of dollars              in    liabilities                are adequately                       resolved,
         we doubt        whether          any s ignificant                     private          sector              interes t

*        will       be forthcoming.

.              Before         discussing                  these     issues        in greater           detail,            I will
    briefly          describe              DOE's enrichment                     program       and summarize                the        Smith
    Barney          report.


               The federal                 government             has enriched             uranium        for       national
    defense          purposes              and commercial                 nuclear         power plants              for        over     30
    years.           Throughout               the         197Os,        the     expected       growth         of    nuclear            power
    led       DOE to      expand            enriched           uranium           production           capacity            at    its     three
    gaseous          diffusion              plants,           begin       construction               of a large-scale                   gas
    centrifuge            enrichment                 plant,        and accumulate                 a stockpile              of enriched

               However,             the     anticipated                 demand for         U.S.       enrichment               services
    did       not    materialize,                   and foreign               suppliers        cut     into        DOE's domestic
    and foreign               markets.               By 1986 the               program      was beset              by many
    problems           that         left      it     facing        a bleak         financial           future.             The
    problems           included              (1) multibillion-dollar                        payments           under           long-term
    contracts           with         the     Tennessee             Valley         Authority           (TVA)        for     electricity
    the       program         did      not         use,     (2) potentially                large       decommissioning                    and
    environmental                cleanup             costs        for     the     three     aging       gaseous            diffusion
    plants,          (3) billions                   of dollars            in unrecovered               costs,            and (4)
    market          uncertainties                   due to        increased         competition.


                          In response              to the        problems             facing         the     program            and the          need to
    .           ensure      its     continued               viability,             DOE initiated                  various            actions.           For
                example,          DOE canceled               the      gas centrifuge                   plant;        permanently                 shut
                down one of             its      existing            three        gaseous           diffusion            plants;           and
                developed          a new, more flexible                         contract             for     providing               enrichment
                services.           In addition,                 DOE made capital                      improvements                  at the       two
                remaining         gaseous           diffusion             plants         that        allow        them to use cheaper
                lfioff-peak"        power.            DOE also            proposed            that         the    Congress            restructure
                the     program      as a government                      corporation.


                          In January             1990 DOE entered                     into      a contract               with        Smith       Barney
                to assess         the         feasibility             of restructuring                      the    enrichment                program.
                DOE wanted          an objective                 review        of the           program           and an independent
                opinion        concerning             the      best       option        to maximize                its        financial           value.
                Smith      Barney        delivered             the       report        to     DOE on May 15,                    1990.

                          In the     report,           the       company concluded                      that       DOE's uranium
                enrichment          enterprise               should          be transferred                  to a wholly                owned
                government          corporation                as the         first          step     toward        creating               a private
                company to operate                    the      business.               The report                noted        that     a
                government         corporation                 should         be able           to make business                      decisions
                without        budgetary            constraints               and political                  interference.
              Smith      Barney       also      cited       a number of                issues       that      could         affect

.   the     future       financial           viability           of the         uranium         enrichment             program.
    The company noted                 that       (1) power costs                    to operate         the        gaseous
    diffusion          plants        could      increase           as a result               of clean         air
    legislation;            (2) costs           to construct                 the     proposed         atomic         vapor
    laser       isotope      separation             (AVLIS)            plant        could     double;         and (3)
    overseas          suppliers,        most notably                   the     Soviet        Union,        could       further
    erode       DOE's market           share.            Smith         Barney        also     noted        that      the
    program        has ongoing           liabilities,                  such as unrecovered                    government
    costs1       and environmental                  cleanup            and decommissioning                    costs,         that
    could       impair     its     ability          to compete               effectively            in the          world


             Smith       Barney       concluded           that         the     enrichment           program          should         be
    restructured           as a government                  corporation                and should           operate          in a
    competitive,           businesslike              manner.             Over the            last     several         years,         we
    too     have recommended                 that    the     enrichment                program        be restructured                    as
    a government           corporation.                  We believe             that        a government             corporation
    could     establish          a flexible              pricing         strategy            to stimulate             demand
    among utilities,               particularly              those           that      have not        renewed          their

    I-Unrecovered    government  costs represent        the cumulative  net
    investment    in the enrichment       program, that is, the difference
    between total     investment   (initial     investment,    capital improvements,
    ope?ations,     and imputed interest)       and total   revenues.
contracts             with      DOE because             they          are waiting              to see where the
program          is    headed.

           However,           we differ          with         Smith      Barney's              conclusions             that        all
past       costs       have been recovered.                            We also         question           the method               that
the     Congress             or DOE would            use to            implement          Smith          Barney's        proposal
that       the     government           retain          responsibility                   for     environmental                 and
decommissioning                 costs        associated               with      enriched          uranium           production
before        the      corporation's               formation.                  Further,          until        problems
related          to    licensing          uncertainties,                     increased           competition,                 and
billions           of dollars           in      liabilities              are adequately                   resolved,            we
doubt       whether           any significant                  private          sector          interest        will          be

Past       Unrecovered            Costs

           One issue--past                unrecovered                 costs--         has hindered             congressional
initiatives             to restructure                  the     program          as a government                    corporation.
Smith       Barney           concluded        that        unrecovered                 costs      are      largely
irrelevant             in view      of the           overall            objective             of establishing                  a
viable,          competitive            corporation               to enrich             uranium.              We have
consistently             pointed          out      that        full      cost         recovery           is   not     practical
and have recommended                      that       the      Congress           define          a reasonable                 amount
of costs           to be recovered,                  including               allowing           DOE to write             off        at
least       $4.1      billion       spent          on upgrading                 the     gaseous           diffusion            plants
anduconstructing                 the      gas centrifuge                     plant.



               As of the           end of          fiscal       year         1988,   we calculate               unrecovered
    costs        to be $9.6             billion.            As shown in table                  1, this          total
    compares           with      Smith       Barney's           calculation              of   $8.7    billion           before
    certain           assumed write-offs                    and adjustments.

    Table 1.. Unrecovere                     d Costs           for     DOE's Uranium             Enrichment             Proaram
    Dollars  in Billions
                                                                 GAO                                             Barnev
    Initial           1969 Value                                $1.5                                             $ 1.5
          Interest   and
          investment                                             8.1                                                7.2
              Total     costs                                    9.6                                                8.7
       Cost adjustments                                          0.0                                               -4.2
       Write-offs                                                0.0                                               -5.7
              Total     decreases                                0.0                                               -9.9
    Total                                                       Sua                                              (S1L2)b
    aAs of the end of fiscal    year 1988.   For comparative    purposes,
    Smith Barney used our methodology     and calculated   this amount to be
    $10 billion  through fiscal   year 1989.
    bAs of the            end of         fiscal        year          1989.

               The difference               between          our and Smith                Barney's       calculations             of
    total       costs         results        from      differing             interest         rates    and other           items,
    such as appropriation                          transfers           and reprogramming               amounts.            We did
    not       reconcile         appropriation                transfers           and reprogramming
    differences.                To calculate                imputed          interest,         we used the              average
    cost      of government               borrowing                 as determined                annually        by the
.   Department           of the         Treasury              for     government             enterprises              that           sell
    goods and services                    to the         public,            such as DOE's enrichment                                program.
    Smith      Barney          used the         long-term              bond rate             as of January                  1969 to
    impute       interest             on the        initial           $1.5        billion          investment             and used
    annual       short-term             Treasury              rates        to     impute         interest        on the
    difference           between          annual         appropriations                     and revenues.                   We can see
    some logic           to the         rates        used by Smith                   Barney.             However,           if      the
    Treasury        would        have to borrow                     the     cumulated             unrecovered               costs           in
    any 1 year,           it     would        borrow           the     funds         at the         average          cost         of the
    government's               debt     at that          point         in time.

              As can be seen from                      table          1, the most                significant              difference
    between        our and Smith                Barney's              unrecovered                cost     calculations                     occurs
    in the      treatment             of adjustments                   and write-offs.                      First,          Smith
    Barney      assumed that               DOE could                reduce         total         costs      by $4.2              billion         to
    reflect        the   market          value         of DOE's uranium                      ore        inventory           and
    overfeeding           activities                ($2.1       billion),                 underpayments              by government
    customers        between            1970 and 1985 ($1.1                          billion),            and other
    adjustments           ($1.0         billion).               We have not                 evaluated          Smith             Barney's
    uranium        ore    inventory             or other              adjustments                in prior        work            and did
    not    have time            to do so for                  these        hearings.              However,           in     December
    1989 we estimated                  that      DOE's government                          customers         are responsible
    for    about     $764 million                of the             $9.6        billion       of unrecovered                      costs.2

    2Letter  to the Chairman,   Subcommittee   on Energy                                                  Research and
    Dev%lopment,   House Committee on Science,    Space,                                                  and Technology.
          Second,          Smith      Barney          assumed a $5.7                billion          write-off,           which
represents            50 percent             of the         cost     of the         canceled           gas centrifuge
plant,          unneeded          upgrades          to the         gaseous         diffusion           plants,       unneeded
power purchases                   from     TVA ($2.6           billion),            and related               interest
charges.             We have supported                     the write-off              of the         gas centrifuge                   and
gaseous          diffusion           upgrades          under        generally             accepted        accounting
principles            as unusual             and nonrecurring                     investment           decisions          that
did      not     reach       completion             or result          in revenues.3

          On the         other       hand,         DOE incurred             the     TVA demand payments                       to
ensure         the    availability                 of electricity             for         ongoing       operations             at
two plants.                We do not believe                  this      write-off              is    necessary           to
ensure         the    competitiveness                  of the        corporation              because          DOE has             (1)
been pricing               its      enrichment          services            to recover              $3 billion,
including            the     TVA costs,             over     the     next     12 years              and (2) projected
that      the     new corporation                   could     generate             over     $3 billion            in net
income         by the        year     2000 and over                 $8 billion             by 2008.

          As a result              of these          assumed write-offs                     and adjustments,                   Smith
Barney         concluded           that      all     past     costs        have been recovered                     and that
DOE's customers                   actually          overpaid         $1.2     billion.               In reality,              total
costs      have not              been recovered              through         revenues;              rather,       Smith
Barney         assumed that               DOE could          reduce        total       costs         through       various

3Uranium Enrichment:    Conaressional                                  Action          Needed to Revitalize                           the
Proaram (GAO/RCED-88-18,   Oct. 19,                                  1987).

            adjustm ents             and policy             decisions            that         we believe                should          be m ade
.           only       by the        Congress.

            Environm ental             Com oliance                and Decom m issioning                        Costs

                      S m ith    Barney           proposes          that    the         governm ent               assum e all
            environm ental             com pliance             and decom m issioning                           costs          prior      to the
            form ation          of the       corporation               and that               DOE initiate                    a com prehensive
            decom m issioning               cost         study.        The report               implies                that      the
            corporation            at m ost would                  be responsible                  for         environm ental                 and
            decom m issioning               costs         after      the    tim e        it     is       form ed          but         does not
            specify          a m ethod       to allocate               these         costs.

                      These      costs       are         largely      undefined.                     Last         year         we estim ated
            that      environm ental               and decom m issioning                       costs           could          total      alm ost           $6
            billion          (1988     dollars)            over      the    next         20 years.                     Yet DOE has not
            com pletely          characterized                or identified                    enrichm ent               plant          weste
            sites,       and past           experience              indicates            that        such costs                  increase             as
            m ore inform ation               becom es available.                         S m ith         Barney           reported            that
            DOE's estimates                 for     decom m issioning                   the     Oak Ridge                plant          alone         could
            be as m uch as $8 billion,                             depending            on the         cleanup                required.               For
            the      three      existing           plants,          these      costs           could           total          $24 billion.

                      We have        long         said     that      decom m issioning                    costs          should          be paid            by
            the      beneficiaries                of the      service          provided.                  If      DOE had implemented
            our,1979          recom m endation               to price          its       enrichm ent                   services          to     set

aside      funds        for     decommissioning,                   we might            not be debating                    this
issue      today.4             In August            1988 DOE finally                   determined                that     its
commercial             and government                 customers          should         each bear                about     50
percent         of these            costs.       To date,              no fund has been established,                                   but
various         proposals            to restructure                the     uranium            enrichment                program
would      require            the    corporation           to establish                 a fund            to decommission
the     three      existing           plants.           We have supported                      the        formation             of a
fund     to help           pay these          costs       rather         than        burden         the      taxpayers            with
this      responsibility.                    We further            suggest           that      the        corporation             be
responsible             for     decommissioning                  all     three         plants         to encourage                it
to put         money into            the     fund      and that          the     government                match         the
corporation's                 payments.          In so doing,                  the     government             would        help
meet     its     responsibility                 for     one-half          of these             costs.

Feasibilitv            of Privatization

         Smith      Barney           concluded          that      transferring                 the        enrichment
program         to a government                 corporation              is     needed before                 the        program
can be sold            to the         private          sector.           Establishing                 a private            sector
enterprise           is,       according         to Smith              Barney,         the     best        way to maximize
the    value      of enrichment                 operations              and ensure             that        the     government
receives         the       highest         possible        price         for     its        past         investment.              In
1986 DOE solicited                    expressions              of interest              for        the     private
operation         of the            enrichment          facilities.                  DOE received                 16 responses.

4Cost to Retire  Uranium Enrichment   Facilities Should                                                       Be Included
in Current Uranium Enrichment   Charaes (GAO/EMD-79-94,                                                        Sept. 6,
    None contained             a serious             proposal,               although       the     American           Enrichment
.   Company,        Inc.,      offered           to take             over     the   gas centrifuge                  facility        at
    no cost.          On the       basis         of this             experience         and for         several           other
    reasons,        we have concerns                    whether           the    corporation            could        be
    privatized.              Let me mention                 some of these               concerns.

            Obtainina          Licenses

            Licensing          facilities               that         are between           30 and 40 years                 old
    could     be difficult.                 Before          the       corporation           could       be privatized,
    each plant         would      have to obtain                      an operating            license          from       the
    Nuclear       Regulatory             Commission.                  No enrichment              facility          has ever
    been licensed             in this        country,              and because             of their          age,      the      plants
    may not       meet regulatory                   criteria           related       to,      for     example,            seismic
    requirements.              Also,        unforeseen               problems        may exist              with
    environmental            contamination,                    particularly             waste       disposal           sites.           We
    have previously              reported            that       DOE does not               have complete
    information         on the           types       and amounts                of material           in these            sites.
    Also,     Smith     Barney           suggests           that       the      corporation           deploy         AVLIS.
    This    plant      too     would        have to receive                     an operating            license.

            Increasins          Competition

            An oversupply                of enrichment                 capacity         exists        worldwide.                Since
    many domestic            utilities           will          not     have contracts               with       DOE after
    1996,     the     U.S.    market         will        become a battleground                        for      suppliers.

In particular,                  DOE estimates             that         the     Soviet        Union          has excess
capacity          of up to 9 million                     separative             work units                 (a measure           of the
effort       required            to enrich         uranium)             and sells            its         product        for     about
50 percent            less       than      DOE.       This       excess         capacity             coupled           with
domestic          utilities'             need to purchase                    enriched         uranium             at the        lowest
cost      leads      DOE to expect                that       the   Soviet            Union         will      become more
active       in the          U.S.       market.          Recently,             the    administration                    asked      an
interagency              trade        policy      group       to examine              the     feasibility                 of DOE's
entering          into         an agreement           to purchase               some of the                Soviet         Union's
excess       inventory.                 Also,     DOE reports                that     China          is    becoming           much
more aggressive                  in the U.S.             marketplace.                 Finally,             a for-profit
consortium           of three            domestic         utilities;                URENCO (a European
producer):           and Fluor-Daniel,                    Incorporated,                 has announced                   plans      to
build      an enrichment                 plant     in Louisiana.

          In summary,             we concur         with         Smith        Barney's             recommendation                to
restructure              the     enrichment         program             as a government                    corporation,               but
we cannot          agree         that      DOE's customers                   have paid             for     all     past       costs.
Obviously,           the        existing         program         cannot         recover            all     such costs,             and
the      new corporation                 should     not       be burdened               to the            point        of being
noncompetitive.                   However,         because         DOE estimates                    that         the
corporation's               future         earnings        could         be substantial,                    we have
suggested          that         the     Congress         require         the        repayment             of $3 billion,
rather      than         rely     solely         on unspecified                 dividends                and/or        uncertain


fu tu r e       stock          sales       th a t     m a y n o t m a terialize                unless           problems            related
to     licensing               uncertainties,                   increased          c o m p e titio n ,          a n d billions             of
dollars           in liabilities                     a r e a d e q u a tely        resolved.

             A lso,     S m ith         B a r n e y did n o t i d e n tify               to tal       e n v i r o n m e n tal        or
decommissioning                    costs            a n d did     n o t specify            a m e th o d to allocate
th e s e      costs       b e tween th e g o v e r n m e n t                a n d th e corporatio n .                        S ince
th e s e      costs       a r e largely               u n d e fin e d ,     b u t could           a m o u n t to billions,
th e     Congress              should        i m m e d i a tely       require         th e program--regardless                             of
its      structure--to                   begin        settin g        aside        fu n d s    for       th e s e     costs.           DOE
estim a tes           th a t     g o v e r n m e n t purchasers                a r e responsible                    for      50
percent          o f th e d e c o m m i s s i o n i n g             costs:       th e r e fo r e ,        th e      government
should          share th e s e            costs         by m a tching          th e     corporatio n 's                   fu n d
c o n tributions.                  This       requirement                 should      c o n tin u e       u n til         th e     existing
p l a n ts     have been decommissioned.

             W e h o p e o u r views                 o n th e     S m ith     B a r n e y analysis               a n d o th e r
inform a tio n            a r e u s e ful            to y o u .       W e would be pleased                       to       r e s p o n d to
a n y q u e s tio n s          th a t     y o u or o th e r           M e m b e r s o f th e          S u b c o m m i tte e s        may        .